Looking to save and invest your hard earned money but not sure which account is right for you? Maybe a pension, maybe an ISA, or maybe even something else? Let’s run through all your options to help you find the best for your money.
Spoiler: they’re suited to different types of savings goals – and both great in their own right. A pension is perfect for longer-term savings, whereas an ISA gives you the flexibility to withdraw cash when you need it – so short-to-medium term saving.
When we say pension, we mean a personal pension, which is a pension that you manage yourself – you decide how much to pay in, and you decide what pension company to use.
A personal pension is a type of private pension, which simply means a pension in your name (private to you), rather than a public pension, which is the government pension, called the State Pension, which you’ll get when you reach State Pension age – currently 66 (68 in 2046).
A workplace pension, which is a pension your employer sets up for you (if you are an employee) is also a private pension.
A personal pension is a great addition to your workplace pension (if you have one), to help build up your savings for retirement. It’s likely the State Pension and even together with a workplace pension is not going to be enough to sustain a comfortable retirement these days.
And if you’re self-employed, a personal pension is pretty much your only option to save for retirement. (You should definitely open one if you’re self-employed! Learn more with our guide to self-employed pensions.)
The great thing about a personal pension is you get to decide who your pension provider is (what company to use), and even where you want your pension to be invested. For instance, maybe in socially responsible investments (such as no fossil fuel companies). With your workplace pension, you often don’t have any choice of provider or investment options.
This means you have the ability to choose a low cost provider, which has a great investment track record – with everything managed by the experts, or, you can choose to manage your investments yourself (called a self-invested personal pension).
Note sure what provider to use? A low-cost and great performing pension provider is PensionBee¹ – they’ll handle everything for you too. Here’s our PensionBee review to learn more.
Now let’s run through the massive benefits pensions have:
When you save into a pension, it’s intended to be tax-free, so when you pay into a personal pension the government will actually give you the tax that you’ve already paid on your income back as a bonus into your pension pot. It’s like free money, can you believe it?
This is technically called ‘tax relief’, and happens automatically too. So every time you pay into a personal pension, you’ll get a 25% bonus added to your account, completely free. (Which is the tax you’ve paid if you’re a basic rate taxpayer.)
And if you’re a higher rate taxpayer, meaning you earn over £50,270 per year, you can claim tax relief on the tax you’ve paid at 40% too. You’ll do this on your Self-Assessment tax return. And the same applies for additional rate taxpayers (earning over £150,000 and 45% tax).
Getting this bonus can help your savings grow a lot quicker in a very short time frame.
No Inheritance Tax
With all pensions, they don’t count as part of your ‘estate’ when you pass away. Your estate is all your money and assets (such as property) added together. And if the total is above £325,000, it will be taxed – and it’s a lot – 40% on anything over that figure!
With a pension the money is passed to whoever you say gets it when you create the pension account. It's often your spouse or civil partner, and of course you can change this. If you pass away when you’re under 75, they won’t pay any tax at all. If you’re over 75, they might have to pay Income Tax.
When you want to retire and start taking your cash from your pension (or even if you haven’t retired yet), you can do this from age 55. The first 25% is completely tax-free, and you can take this as a tax free lump sum if you want. After that, you might have to pay Income tax on the remaining 75%.
However, depending on how much you take each year, you may not end up paying any Income Tax as you’ll still have your Personal Allowance of £12,570 of ‘taxable income’ to earn first – just how your income (e.g. salary) works now.
You can also move all of your pensions into the same personal pension scheme (called consolidating your pension), and so potentially benefit from lower fees in total (the more you have saved with a provider, typically the lower the fees). Plus, you’ll be able to manage and view your pension all in one place. And importantly, not forget about any of them!
For instance, you might have had many jobs over the years, all with their own pension. You can actually move all of these over to a personal pension, so they’re all in one, easy to manage, pension pot.
Here’s where to learn more and how to transfer your pension.
There’s a few things to bear in mind before you start investing your money in a personal pension:
- There’s a limit on how much you can invest per year, which is £40,000 or 100% of your salary (whichever is lower). This includes your workplace pension too.
- There’s a Personal Lifetime Allowance of £1,073,100. When you withdraw cash after this amount, you’ll pay an extra 25% in tax.
It’s unlikely these will affect you, and you’ll probably know if they do – but they’re worth considering when planning your savings. And if you are going to pay in a bit too much, that’s where an ISA can come in very handy.
Pros and cons of pensions
Here’s a quick recap of the pros and cons of pensions:
- You decide where and how your money is invested.
- You can combine all your pensions into one (consolidate) at any time.
- You can have more than one personal pension.
- Automatically get a massive 25% on everything you pay in.
- This increases to a 40% bonus if you’re a higher rate taxpayer (45% for additional rate).
- No Inheritance Tax.
- No Income Tax to pay for your beneficiary if you die before 75.
- The first 25% you withdraw is completely tax free (and you can it take as a tax free lump sum).
- You can’t access your money until at least 55 (57 from 2028).
- You’ll pay Income Tax on 75% of it (if it’s above your Personal Allowance).
- You can only contribute up to your whole income (e.g. salary), or £40,000, per year.
- There’s a lifetime allowance of £1,073,100, after this you’ll pay tax.